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Wednesday, September 12, 2012

An economic development plan for Greece

I re-post an article below which I had first published in June 2011.

Point of departure

The Greek economy is in shambles. Greece has absolutely no chance to comply with
the austerity requirements on a sustained basis because the economy of Greece
is a basket case and because there seem to be no plans whatsoever (neither on
the part of Greece nor on the part of the EU) how the economy could get going
again. There is no industrial development plan how
to convert a corrupt and crony-driven economy into a value-generating market
economy. This is not a project for a few months, nor even for 2-3 years. This
is a project for an entire generation and it has to be planned accordingly.

Economists have calculated that Greece, since
the Euro, has become roughly 40% more expensive relative to Germany. However,
the Greek Euro has maintained the same international purchasing power as the
German Euro. Consequently, Greece has imported products and services from
abroad instead of producing them domestically. The Greek economy has become a
zombie-economy which had lost its business model long before the financial
crisis of 2008: 80% of the economy consists of services, i. e. “selling each
other souvlaki at inflated prices and paying for them with money borrowed
abroad”.

Looking back

From 2001-10, Greek imports amounted to 446
billion EUR compared with exports of only 146 billion EUR. Despite the present
recession which brought imports down and even increased exports, exports still
only cover 40-45% of imports (compared with 78% in the USA and even 93% in
Italy). The current account deficit during this period was 199 billion EUR!
This luxury of the Greek economy was financed through foreign savings.

From 2001-10, the gross external debt of
Greece increased from 121 billion EUR to 409 billion EUR; representing a net
increase of 288 billion EUR. Most importantly, the foreign debt of the private
sector (212 billion EUR) is higher than the foreign debt of the public sector
(187 billion EUR). Even if all of Greece’s sovereign debt were forgiven and
even if the budget could be balanced, the problem of the Greek economy would
remain.

The Greek economy literally “burns” money.
The current account deficit for 2011 was still as high as 21 BEUR. Deposit flight from January 2010 - March 2012 was in excess of 70 BEUR.
In the past, the ECB has filled this “hole” by lending money to the Greek
banking sector. Picture the following: the ECB sent tax payers money to the
Greek banking sector so that wealthy Greeks could – perfectly legally via bank
accounts – transfer their own money abroad and so that the Greek economy could
import goods instead of producing them domestically! How much longer will the
ECB be able to do this? (presently, they have lent roughly 100 billion EUR to
the Greek banking sector).

Diagnosis

Greece is not a bottom-less pit. However, it is a pit with 3 big holes: budget deficit, current account deficit and capital
flight. Quite a bit has been done already with regard to the budget deficit but
more needs to be done. Nothing has been done yet as regards the current account
deficit and capital flight.

If Greece does not get a handle on the
current account deficit and on capital flight, the country has absolutely no chance!!!

An industrial development plan needs to aim
at reducing the current account deficit and at eliminating capital flight.
Exports can probably not be increased at a significant rate because Greece does
not have all that much to export (yet). Revenues from tourism can probably not
be increased significantly, either, because they are already very high and
because Greek tourism – objectively speaking – isn’t really all that
competitive (Greek tourism lives very much on cult).

Consequently, it is imports and capital
flight which are the two factors left which could make a difference, and a big
difference they could make indeed! Imports must be drastically reigned in (and
replaced, as much as possible, with domestic production) and capital flight
must simply be stopped outright.

If Greece left the Euro and returned to the
Drachma, all of the above would happen automatically: the new Drachma would
devalue by at least 30-40% making all imports more expensive accordingly;
capital flight via bank accounts would no longer be possible because banks
would not have the necessary local currency.

A Euro-exit, above all an uncontrolled one,
would probably be the worst of all evils in the present chaos. Financial assets
of Greeks (savings) would overnight become 30-40% worth less in terms of
foreign currency. Bye, bye social peace!

A possible solution

If a Euro-exit is the worst of all evils and
if Greece cannot make it with the present Euro-structure, then Greece must hold
on to the Euro and simulate a situation – at least temporarily – as though she
had returned to the Drachma.

Temporary measures: special taxes on imports
in order to make imports altogether 30-40% more expensive (on a staggered
scale, however: 0% for priority imports; 100% for luxury imports); selective
Free Trade Zones where internationally competitive business conditions are
allowed so that new domestic production for import substitution can be started;
and capital controls.

This would violate EU-treaties (free movement
of goods/services) but treaties can be amended, if only temporarily. This is an
emergency and an emergency requires emergency legislation. For the EU it would
clearly be more beneficial to approve such amendments so that Greece can build
up a value-generating economy instead of continuing to send tax payers money to
Greece so that a zombie-economy can be kept up.

A new Investment Law of constitutional rank
must be established which assures the potential new investor all the
internationally competitive business conditions which he desires. Since no one
seems to trust any Greek law any more, the EU should guarantee compliance with
this Investment Law so that investors do not have to carry any political risk
(economic risk they have to carry!).

The investor would find an economic nirvana:
he can produce competitively and he already has an assured market demand. And
he is covered against all sorts of Greek political risk.

Wealthy Greeks hold hundreds of billion Euros
in foreign bank accounts. The new Investment Law must aim at the voluntary
return to Greece for new investment of parts of those funds. Greeks are good businessmen
and they recognize a good business opportunity quickly. Why should wealthy
Greeks prefer to earn 2% in Switzerland when they could earn a multiple thereof
in Greece with the same security?

Why selective Free Trade Zones and not the
whole country to begin with? Because one cannot restructure a country’s economy
from A-Z at one and the same time; that would lead to a revolution. Instead,
the objective has to be to make the Free Trade Zones work well and to hope that
their economic framework will rub off on the rest of the economy over the
years.

Of foremost priority is good business
governance in the Free Trade Zones; everything must be on correct and
transparent footing. If the Greek way of doing business (tax cheating,
corruption) set foot in the Free Trade Zones, the project would be doomed from
the start. There would have to be efficient control mechanisms such as regular
audits by reputable auditing firms. Perhaps even periodic EU-inspections (after
all, they guarantee compliance with the Investment Law).

The great risk associated with import
controls is always that this protection of the domestic economy is misused by
domestic manufacturers. Suppose an imported tooth paste costs 1 EUR per tube
and the new internationally competitive conditions in the Free Trade Zones
allow the domestic manufacturer to also operate profitably at that price.
Assume further that a 100% special tax will temporarily be imposed on the
imported tooth paste so that the domestic manufacturer can start up his
business. Thus, the imported tube will now cost 2 EUR. The risk is that the
clever Greek businessman may now want to sell the domestically manufactured
tube at 1,99 EUR.

This is not how the system can work! The
objective of the Free Trade Zones is to build up sustained domestic
manufacturing. They cannot be misused by clever Greek businessmen to produce
competitively but sell at twice the price. The benchmark always has to be the
international price!

Closing commentAll of this sounds very much like a planned
economy, but it isn’t. It all depends on the new Investment Law is formulated.
The law has to establish firmly those rules within which entrepreneurs can act
freely and to their profit. An effective Investment Law will offer the investor
an attractive relationship between security, risk and reward. If that is
accomplished, the investors will come on their own.

Chile showed in the late 1970s how a good
Foreign Investment Law turned a formerly communist and planned economy in a
short time into the „darling“ of foreign investors. Why should Greece not be
able to accomplish the same? (particularly with the EU-guarantee, of which
Chile had no equivalent).

Argentina has attempted several economic
stabilization plans over the decades and for a limited period of time they all
seemed to work. The foreign money of Argentines always returned quickly to the
country and accelerated the recovery. However, as soon as the first clouds
appeared on the economic horizon, that money left the country as quickly as it
had come. Greece must accomplish the “trick” to create the kind of economic
framework so that the foreign financial assets of Greeks stay in the country on
a sustained basis.

The government must assure that many
investment opportunities are always on offer for investors. They must be well
presented and accompanied by base case business plans, and they must be
publicly tendered. The government could even involve some PR-coverage to
stimulate a “run” on such new investments (based on the theme: “let’s get in
before the door perhaps closes again”).

The issue of Greece’s sovereign debt was
purposely not addressed here because that problem is, in comparison, the
smaller problem. A foreign debt problem can be solved with a few hundred people
in a conference room (provided that they can agree on something). However, to
develop an industrial development plan for the Greek economy and to
successfully implement it, that requires the best brains not only of Greece but
also of Europe.

But: once there is an industrial development
plan for Greece, the sovereign debt problem will be much easier to solve
because the country’s creditors could, for once, have the hope that there could
be light at the end of the Greek tunnel!

The North is getting impatient with Greece and does not want to send more money. However, the North must be aware that one cannot have the cake and eat it at the same time. Either the North supports and promotes increased economic value generation in Greece so that Greece can develop its own, self-supporting economy, or the North will have to accept the fact that permanent transfers are unavoidable.

10 comments:

Development plan is the key Klaus. Good point of view. But the issue also is the business idea. Many people have ideas and they are creative, truly inventional. There aren't ideas only how to cheat someone or to exploit locals by creating an unnecessary service especially and not producing real useful hard assets products for which we are in need.Even if ideas do exist the bureaucracy is a barrier and the steps need to follow people tiring.I don't know if Free Trade Zones will deal with issues of how to finish a successful investment properly.Already exists Fast Track which aim is to follow every investment and facilitate when there are obstacles. However its not a matter only of Investment Laws but how Courts perform, if the Land Registry will ever finish(Troika totally forgot that).Some things need to mature to give good results, but do change. Doing business evaluation will change the following years.About the exports- imports 146 - 446 you mention only trade balance (goods)not services etc ? Or Balance of Payments?At the end, more than 800 mil surplus on Aug. Possible primary surplus for 2012 with recession -7% as i said in previous message. Never seen it as a result in modern economic history. (even after dept exchange)Do you?This is a very good exelixis if we admit that some (not all) reforms do not apply effectively.Reduced prices in some goods and services is still an issue.

I mentioned both, the trade balance (-300 BEUR) and the current account deficit (-199 BEUR). Personally, I think the current account balance is a better indicator than the trade balance because IT IS important if a country, like Greece, can generate foreign revenues also through services. Suppose Greece could compensate through services (tourism) everything it overspends on trade, that would be perfectly fine. There are many areas in the world whose living standard depends entirely on tourism (Austria, for one, would be in dire straits without tourism). What matters is that you have sufficient foreign revenues to cover the foreign expenses.

Yes, the current account balance has improved sensationally. However, I am told that this is almost entirely due to the recession/depression. No money in people's pockets, no money for imports. When money returns into people's pockets, imports will sky-rocket again (because the domestic economy does not deliver the goods which consumers want).

Exports have increased impressively in recent months but I hold my breath on that. First, they are still no higher than back in 2008, at a time when Greece was more expensive than today. Secondly, with the Euro having declined against the USD and with Greece having become cheaper, exports should actually have exploded (particularly to non-EZ-countries).

I repeat over and over again: Greece must increase the domestic value creation so that not (nearly) everything needs to be imported. And through increased domestic value generation, domestic employment will go up.

I am not familiar with Fast Track. It seems it is one more instrument, like the SEZs which I recommend, to make life easier for enterprises. I don't think of an SEZ, even though many suggest that, as a place full of perks. No, I think of them as a place where life is perfect for enterprises. Let me close with a quote from Churchill:

"Some people regard private enterprise as a predatory tiger to be shot. Others look on it as a cow they can milk. Not enough people see it as a healthy horse, pulling a sturdy wagon".

The EU has neither the skills nor the authority to devise and implement a Greek national development plan.

Did it do it for the former Warsaw Pact states - NO.Is it doing it for the former Yugoslav states - NODid it do it for Ireland, Spain or Portugal - NO, NO and NO.

This notion that that the EU should take responsibility for the Greek economy is like the Greek tourism industry - another mythical cult. The one that says the rest of the world owes Greece a living because it's the cradle of democracy. Modern democracies have their roots in Scandinavia - the only thing that comes from Greece is the word.

All national economies are planned, in democracies _plans_ are often called _policies_. The US has 'earmarks' (military bases), SoE's (Fannie, Freddie, NY Fed) corporate bail-outs (AIG, GM), subsidies (ethanol, dairy), funding and blocking of enterprises (Solyndra, XL Keystone) etc.

How would an EU formulated and guaranteed "Investment Law for Greece", be administered? Hopefully by a juridical authority and not some Star Chamber in Rome or Worms. Who would be expected to obey such a law? Presumably the Greek Government would one such party. What penalties could be imposed on Greek politicians and bureaucrats - jail, exile to St. Helena? Is there a court to do that - no; so lets have a European Court of High Crimes and Miss-Demeanors in Paris, the capital of Farce.

In reality all the EU can do is to provide advisory expertise (as can McKinsey's, BCG, Goldman's etc), project finance via the EIB, SAF etc, and not get in the way.

Ireland did not need an EU Investment Law to attract US IT and Pharmaceutical industries, nor one to foster the growth of a local software industry, some of which used the wealth of returning expats. Nor did the Irish government need Brussels' permission to lower corporate tax rates or set up technology parks (micro SEZ's). They just did it, because that's the job they were elected to do.

It seems you're advocating that the EU take over the responsibilities of the Greek Government. Do you also advocate the democratic participation of the other 400+ million EU citizens in electing the surrogate Greek Government.

If the Greeks want someone to run their country for them, then they should ask the Turks if they want to resume control. Or they could ask Putin if they can join his Eurasian Economic Union; which would, in many respects and in my opinion, be a better fit to the Greek 'condition'.

KK wrote - "Either the North supports and promotes increased economic value generation in Greece so that Greece can develop its own, self-supporting economy, or the North will have to accept the fact that permanent transfers are unavoidable."

The first option is only available to the North if GREECE takes the initiative.

So the North is seemingly stuck with the second option, as evidenced by recent decisions in Frankfurt & Karlsruhe.

That is until some country gets the courage to say enough is enough, and exits the Euro, potentially triggering a disorderly collapse of the EMU. Or the Euro Elites could concede that the EMU is a failure, that can't be fixed with band aids or can kicking. That it needs root and branch re-engineering, and to do that it must first be dismantled in an orderly manner.

Let me respectfully say this: I sense in all your comments the premise that Greece as a society is more or less on par, or should be considered as such, with other EU-countries.

I think that is the wrong premise!

I think Greece is in many respects a developing country, a developing country that happens to be an EU-member and gets measured by EU-standards. I mean: where in the world do you see such archaic public administration as in Greece? (I think even in the underdeveloped world, certainly in the emerging world, would you have to search quite a bit to find parallels).

Blame the Greeks for that? No, blame their history! From the time Greece became a Roman province (2nd century BC) until 1832, Greece was an "addendum" to something else; first to the Romans, then to the Ottomans. So Greece never developed the public administration which a country develops when it is on its own. And their Roman/Ottoman leaders certainly did not add value to Greece like, say, the British added value to colonies.

Greece largely missed out on the major historical processes which shaped the rest of Europe: the Reformation, the Separation of Church and State, the Rennaissance, the Enlightenment, the Industrial Revolution, etc.

I am sure there are still people alive in Greece today who remember a childhood/youth in their villages when life was not much different from medieval (if not ancient) living standards. People who had slept on floors (instead of beds) in their childhood, who had to grow older to see roads and cars, etc. I certainly remember my first visit to my wife's village back in 1977.

The entire structure of society still reflects that today. Where you had feudalism in the Middle Ages, you still have cronyism in Greece today. You have some of the most sophisticated societies in urban centers and you have some very simple-minded (if not naive) societies in the country.

Of course, it is politically incorrect to say this but the fact of the matter is that Greece needs development aid like any other developing country.

I could argue that the more underdeveloped a country is, the more sophisticated its elites are. Their children are educated at the best schools of the world. And they develop all the skills which make them the democratic equivalent of the lords of the Middle Ages.

I would think that it should be a piece of cake for the Greek elites to get their country into shape, if they only had an interest in doing that. But which lord in the Middle Ages took the initiative to deprive himself of power, influence and wealth?

If one starts from the premise that Greece should, por favor, perform similarly to other EU-countries, one will only be disappointed. One has to start from the premise that Greece needs development aid.

Now that, of course, requires two conditions precedent. One, the elites must allow that their country is being developed and, two, the Greeks need to acquire a realistic self-recognition and accept that they need development aid. I think both are equally large hurdles. The elites have no interest to lose their playing ground and Greeks are not known for their ability to self-recognize and to seek help.

Klaus,everybody should be a great admiror of the British phlegm, or even a kind of it, a bit underrated probably of an Old Colony.Also the English insurmountable contribution to every aspect of life, sciences, literature, music etc. However I understand the burden for a few who live under the illusion of the past Empire, it's difficult ! Let remind only with my truly bad Latins "difficilis est directum pro totus"

Greece has the same privileges as any other EU member, so it should have the same obligations as any other EU member. If it can't live up to those expectations then it should exit the EU.

If it did then it would enjoy the benefits of being an un(der)-developed country. It could call on agencies like the UNDP and World Bank for advice & loans. It could get third-world development aid from the EU. It could join NAM, Jim O'Neill could put in one of his acronyms.

But most of all it could get aid from EU member states, most (all ?) of which channel the bulk of their foreign aid via their own or UN institutions rather than the EU. The EU as an institution has no record of being a major development agency. It's barely been able administer Kosovo, so why should we expect it to solve the problems of Greece.

The history of Estonia is not so different from Greece, in terms of foreign masters etc - although it never had an Empire, so it never ruled any foreign countries like Greece has. Estonia became free of its most recent occupier about 20 years ago, whereas Greece got rid of its Ottoman masters almost 200 years ago. If Estonians can pick themselves up by their bootstraps, why can't the Greeks - maybe histoiry has something to do with it.

I do believe the Greeks had quite a bit to do with the Byzantine Empire, the fact the the Patriarch of Constantinople is the nearest thing the Greek Orthodox Church has to a Pope is a testament to that. And the Roman Empire (as opposed to the Roman Republic) was in the eastern region at least as much a Greek affair as it was Roman. No other colony ever had such a major influence on its colonisers as the Greeks did on the Romans. After 620AD Greek was the official language of the Byzantine Empire.

Gibbon on the Byzantine Empire - "the Byzantine Empire was vitiated by a bureaucratic over-elaboration bordering on lunacy: quadruple banked agencies, dozens or even scores of superfluous levels and officials with high flown titles unrelated to their actual function, if any. Access to the Emperor and his council was controlled by powerful and inscrutable eunuchs and by rival sports factions."

What we see in modern day Greece is more of the same.

Whilst ever the Greek Elites and Hellenophiles see the EU as part of the solution and not as part of the problem then I believe Greece is doomed to becoming the first failed state from the first world.

If Greece was relegated to the European Customs Union, it would enjoy the benefits of being a most favoured country with respect to trade, but it would not be constricted by EU Treaties and rules - nor would the EU or its member states be restricted in terms of giving it aid and assistance - they could even forgive Greece some of its OSI debt. They could help it set up SEZ's - but it would not have access to the ECB alphabet soup bowl.

Assume, for a moment, that a prominent EU-politician like Barroso, Hollande or Cameron would make a proposal along your lines. I fear all hell would break loose over the fact that someone wants to relegate Greece into the role of a second-class citizen of Europe. All the good media would tear that person apart and the Greeks would have one more reason to exercise the victim's role which they do so well. And if Merkel were to suggest this, more than all hell would break loose.

It might be different if the proposal came from Greece itself.

Personally, I was not aware of all the alternatives which might to open to Greece which you mention. As I said, they sound plausible and you could sell me on that. I just don't think that rational thinking is what carries the day these days.

I agree Klaus, the big boys, as in the EU, Germany, France, UK&NI... have played their cards and failed to take a trick. So they've lost any credibility they may have ever had. Besides they lack the imagination and courage to put forward any alternative ideas.

But if Poland were to say something like :-

The attempts to set Greece on a better path to prosperity have failed. Those that believe that more of the same will bring about a different outcome presumably also believe in the tooth fairy.

The failure of the EU solution to cure the Greek condition is not only bad for Greece its also bad for other EU member states, and its bad for the EU itself.

There is little prospect of the current generation recouping the money it's handed over to Greece. Non Greek EU citizens and many of their politicians are getting fed up with the attention, intellectual energy and money that's being given to (squandered on) Greece.

Measures such as fiscal pacts, banking unions, transfer unions et-al are being considered and implemented with too much haste, too little care, and inadequate consultation with the people. It could even be argued that they present a clear and present existentialist threat to the EU itself.

When in a hospital one has a very sick patient with a contagious disease you don't leave the patient in the emergency centre. Nor do you put them in an open general ward alongside everyone else, with once a day visits from a bevy of junior doctors. No, you put them in isolation and give them intensive care; under 24hr watch by senior nurses and frequent visits by a platoon of specialist doctors.

What Greece needs is intensive specialist care, which is well beyond the scope & capabilities available from General Issue EU system.

You know the rest. Why Poland ?

They're big enough to be 'important', hence be listened to, and they don't have much skin in the game hence little to lose in maintaining the status-quo.

I've been impressed by the manner in which their Foreign Minister can present an argument, such as "Why Euro candidate countries should have a voice, but not a vote, in Eurogroup meetings".

Poles are renowned for sticking their heads above the parapet and taking on impossible tasks. They may not win, but they often display remarkable courage, or to put it another way - they have more chutzpah than most other EU members.

Its just possible that the Greeks might listen to Poland, they probably view it as a fellow victim of foreign oppression. It's even possible that the Brits would look more kindly on the Greeks, and give them back their marbles to play with.

Thanks for the compliment of posting my comment as one of your posts - I'll treasure that :)

EU guaranteed free economic zones carry legal, democratic and financial (to what extend does the EU pay) issues that imply those will take many years. Taken into account the real problem, I think a strong shock is necessary.

Since 2008 it was clear that the Greece economy could not compete due to salary/performance levels, regulations, etc.With the first bail-out, about 2,5years ago, the Greek government strongly promised privatisations and deregulations in order to restore competitiveness, as well as reductions in salary costs and improved tax collection.

Only a small fraction of the promised privatisations and deregulations were implemented.E.g. only 10% of Hellenic Telecom was sold. So it is still a state company with the old bad service levels. Whereas, in line with the EU regulations, Telecom in other EU countries was fully privatized in the nineties.Due to this lack of (willingness to take) action, the efficiency of the economy didn't improve towards a normal EU level.

The salary costs were roughly 50% to high, taken into account the inefficient economy. Those costs went down only slightly but are still far to high.So, while Turkey is booming as holiday country, Greece is not...As long as these problems are not solved the Greek economy will not recover.

That implies that:- sending even more money to Greece will not solve the problems. Worse, Greek will need more money again after a few years...

- Greek politicians will only implement the necessary steps if they are forced, e.g. because there is simply no money. Then it becomes really necessary to implement those (just as in e.g. Argentina). After that Greece will gradually get a flourishing economy again.

Of course Greece will have a (partial) default.But Greece can continue to use the euro despite the default, just as e.g. Montenegro does.That is the best and probably only real solution.